Stronger Dollar Weakens Credit Outlook

Excellent piece from Moody’s:

The ongoing appreciation of the dollar exchange rate stems from the US’s relatively better growth outlook vis-a-vis the rest of the world. However, an unduly strong dollar risks constraining the global competitiveness of US-based production and reducing US corporate profits by enough to significantly weaken prospects for US business activity.

Compared to the respective averages of 2011-2013, the dollar was recently up by 81% against Brazil’s real, 46% versus Japan’s yen, 31% versus Canada’s dollar, 28% against Mexico’s peso, 22% against the euro, and 21% versus India’s rupee. Moreover, according to the same serial comparison, the dollar recently was higher by 19% versus a broad basket of foreign currencies and up by 25% in terms of major foreign currencies.

(…) Higher short-term interest rates are likely to further appreciate the dollar exchange rate and, thereby, put additional downward pressure not only on industrial commodity prices, but on the prices of internationally traded goods and services as well. (…)

Moody’s industrial metals price just fell to its lowest reading since July 29, 2009, which was at the end of the first month of the now 73-month long economic recovery. The latest -26.8% year-to-year plunge by this reliable indicator of global industrial activity reflects an ample surfeit of world production capacity vis-a-vis global expenditures. Continued dollar exchange rate appreciation risks worsening the plight of countries and companies having meaningful direct exposure to industrial commodities.

The dollar last experienced a comparable upswing amid a well-established economic recovery during the late 1990s and into 2000. Partly in response to 1996-2000’s -1.5% average annual rate of deflation for the US import price index excluding petroleum imports, the average annual rate of core PCE price index inflation slowed from 1991-1995’s 2.7% to 1996-2000’s 1.6% notwithstanding an accompanying acceleration by the average annual rate of real GDP growth from 2.6% to 4.3%.

Neither did a climb by the ratio of payrolls to the working-age population from 1995’s 59.1% to1999’s 62.2% prevent a deceleration by core PCE price index inflation. By contrast, payrolls recently approximated a comparatively slack 56.6% of working-age Americans. Given the strong dollar and considerable underutilization outside the US, faster wage growth in the US may have the unwanted effect of further impeding the competitiveness of US production to the eventual detriment of the US labor market.

Dollar strength helped to curb the average annualized growth rate of pretax profits from current production from the 11.0% of the five-years-ended 1995 to the 2.1% of the five-years-ended 2000. Year long 2000’s -5.9% annual contraction by profits helped to trigger 2001’s recession.

The moving yearlong average of profits from current production has already slowed from the 14.9% of the three-years-ended March 2012 to the 3.3% of the three-years-ended March 2015. An even stronger dollar portends a further deceleration by profits, if not an outright annual contraction.

Despite faster than 4% real GDP growth, corporate credit quality deteriorated amid the last extended episode of dollar appreciation. After averaging 368 bp during January 1994 through July 1998, the high-yield bond spread would then average 611 bp for the remainder of the recovery, or until February 2001.

The high-yield bond spread’s widening could be ascribed to a drop by the national activity index’s average from January 1994-July 1998’s +0.30 to August 1998-February 2001’s +0.09. Apparently, the national activity index’s loss of momentum mattered more to corporate credit than did the accompanying acceleration by the average annual rate of real GDP growth from 3.8% to 4.2%.

The national activity index’s -0.01 average of Q2-2015 helps to explain why the recent high-yield bond spread of 520 bp tops its 418 median of the previous two economic recoveries. Moreover, the drop by the national activity index’s average from H1-2014’s +0.15 points to H1-2015’s -0.06 was joined by a widening of the high-yield bond spread from 362 bp to 478 bp, respectively.

Wider Spreads May Be Anticipating Diminished Profitability

Corporate bond yield spreads are likely to widen, once profits shrink on a recurring basis. Since 1987, the yearly change of the high-yield bond spread’s quarter-long average shows a meaningful inverse correlation of -0.67 with the yearly percent change of profits from current production. Year-to-year declines by such profits were accompanied by an average 161 bp year-to-year widening for the high-yield spread, where the sample’s midpoint, or median, was a 96 bp increase. (Figure 3.)

More on this at the end.

Why Canada May Become a Problem for Janet Yellen

Federal Reserve Chair Janet Yellen said less than a month ago that she expected the dollar’s drag on the American economy to dissipate. She may not have foreseen that the greenback would surge to an 11-year high against the currency of the U.S.’s biggest trading partner. As the greenback’s advance against the euro and the yen subsided, its 5 percent rally against the Canadian dollar this quarter may prove to be more detrimental to the world’s biggest economy. The U.S.’s northern neighbor buys about 17 percent of America’s products, more than any other nation, data compiled by Bloomberg show. And shipments have already declined after reaching a record last year.

BTW #1:

• Canadian June trade deficit narrows sharply

The Canadian merchandise trade deficit narrowed to a much smaller than expected $0.5 billion in June 2015 from May’s revised $3.4 billion (was $3.3 billion) shortfall. Market expectations were for a $2.9 billion deficit in June.

Exports jumped by 6.3% to retrace cumulative declines during the first five months of 2015. Imports declined by 0.6% after rising by 0.5% in May and falling by 1.8% in April.

On a volumes basis (using 2007 chained dollars), exports increased by 4.8%, entirely the result of rising non-energy exports, to sit at an all-time high in level terms. Import volumes slipped by 0.8% in June following a 0.3% gain in May and 1.6% drop in April.

The improvement in the June trade balance in volume terms was much larger than expected and, even with earlier weakness, left the net trade balance tracking a 0.5 percentage point addition to second-quarter 2015 gross domestic product (GDP) growth that is stronger than the 0.7 percentage point drag that we had assumed before the report. We expect strong export growth will also be reflected in stronger manufacturing and wholesale trade activity in June, which would contribute to GDP growth in that month returning to the positive column after five consecutive declines to start 2015.

Earlier declines still point to quarterly GDP declining about a percent in the second quarter as a whole to build on the 0.6% drop in the first quarter, with offset to stronger than expected net trade coming from a larger pullback in inventories. Nonetheless, the rise in June exports and improvement in the trade balance were consistent with our view that the economy will return to a positive growth path in the third quarter of 2015, as strength in the US economy and a weaker Canadian dollar provide support to external demand, thereby helping to offset ongoing weakness in the oil and gas sector. (RBC)

BTW #2:

• Who’s Holding Back U.S. Exports?

Net trade has been a thorn in the U.S. economy’s side over the past year, subtracting more than 0.5 ppts from GDP since mid-2014. A strong US$ and soft growth
abroad have clipped U.S. merchandise exports by 5%, or by just over $40 billion (first half of this year vs. first of 2014). What’s notable is where those export
declines have come from: While markets always fret about European turmoil, or China’s slowdown, or Japan’s funk, the drag on U.S. exports is much closer to
home. Exports to Canada were down a whopping $10.9 billion from year-ago levels in the first half of the year, by far the single biggest source of drag in H1. Here’s a quick accounting of the biggest declines:
Canada -$10.9 billion
Europe -$5.1 billion
Brazil -$4.0 billion
OPEC -$3.0 billion
China -$2.6 billion
Colombia -$1.5 billion
Japan -$1.1 billion

German Manufacturing Exports Surge Upward

Data from Germany’s economics ministry showed Thursday that manufacturing orders, adjusted for seasonal swings and inflation, surged 2.0% in June from the previous month, bringing the volume of total orders back to levels last seen in April 2008. (…)

But economists warned that the data—beating forecasts of a 0.2% monthly increase—were inflated by an unusually high volume of bulk orders.

AIDA Cruises, a German cruise line which belongs to Carnival Corporation, placed orders in June for two new ships with Meyer Werft in Lower Saxony. Airbus Group SE, which builds single-aisle planes in Germany, also reported strong aircraft orders during June’s Paris Air Show.

“Excluding such effects, demand was up a more moderate 0.3%,” said Andreas Rees,UniCredit’s chief German economist.

Strong foreign demand also bolstered manufacturers’ order books in June, the ministry said, with a weaker euro exchange rate making eurozone goods more competitive overseas.

Orders from outside the eurozone surged 6.3% from May, while eurozone orders rose 2.3%. Domestic orders meanwhile fell 2.0%, a sign that external demand is increasingly driving economic activity here. (…)

German Industrial Production Drops as Chinese Slowdown Looms

Output, adjusted for seasonal swings and inflation, fell 1.4 percent after rising a revised 0.2 percent in May, data from the Economy Ministry in Berlin showed on Friday.

German manufacturing output fell 1.3 percent in June, driven by a 2.6 percent slump in the production of investment goods, the ministry said. Construction plunged 4.5 percent, while energy output rose 2.3 percent. Total industrial production stagnated in the second quarter.

French industrial production fell 0.1 percent in June and manufacturing output dropped 0.7 percent, national statistics office Insee said on Friday.

MORE FACTS ON CHINA

On the external demand front, however, container freight shipping was weak, registering no sequential growth and a decline in Y/Y growth in the month of July. Currently, shipping volume to North America, Japan, and Southeast Asia is relatively stable but Europe, Red Sea, and Africa volume is weak.

CEBM’s property survey indicates that July completed sales declined compared to June, with the exception of the Beijing market, which registered strong M/M growth. Some developers, primarily located in tier-1 and some tier-2 cities, reported their willingness to start new projects has increased. They believe structural growth opportunities still exit in these cities. (CEBM Research)

Oil Firms Struggle to Turn Off Tap Despite cutbacks and idle drilling rigs, American energy producers are finding it hard to turn off the taps that have helped lead to a global glut of oil.

Rising crude production was a major theme in the past week as shale drillers reported their second-quarter earnings.

Devon Energy Corp. and Whiting Petroleum Corp. said they pulled record amounts of oil from the ground. Anadarko Petroleum Corp. revealed that in some areas it has doubled the number of wells it can drill with a single rig. And Pioneer Natural Resources Co. said it plans to ramp up its drilling activity to pre-oil bust levels by early next year.

Analysts say American oil pumpers need to cut their output by at least 500,000 barrels a day to stem the oversupply that has sent oil prices tumbling over the past 14 months to just under $45 a barrel.

But monthly oil production rose steadily through March, peaking at a record 9.7 million barrels a day that month and just slightly less in April, before edging down to 9.5 million barrels in May, according to the latest federal data. (…)

Roughly 200 oil drilling rigs—about a third the number working today—will also need to come out of the field by 2016.

But companies keep finding ways to drill wells faster and cheaper in an effort to deal with oil that is selling for half the price it was a year ago. They had little incentive to be so innovative when crude oil traded at around $100 a barrel. (…)

Whiting, the biggest shale producer in North Dakota, pumped 170,000 barrels of oil equivalent a day in the second quarter—a record amount for the company.

“We are tooling Whiting to run and grow at $40 to $50 oil,” Chief Executive James Volkersaid.

Amid a refrain about keeping growth in check, executives at Anadarko, a Texas-based oil and gas producer, told analysts last week that the company has doubled its rig efficiency. Anadarko can now drill 70 wells with one rig in Colorado’s Wattenberg field, compared with 35 wells per rig a year ago. (…)

Meanwhile, Pioneer Natural Resources, based in Irving, Texas, expects to pump at least 10% more oil this year than it did in 2014, and earlier this week reiterated plans to add two rigs a month back to its oil patches between now and year’s end. It will also add eight rigs in the first three months of 2016.

That ramp up, Chief Executive Scott Sheffield said, will bring drilling activity back to the level it was before oil prices collapsed in late 2014. (…)

Steven Mueller, chief executive of Southwestern Energy Co. in Houston, said he sees little incentive to grow right now, but can’t justify holding off on drilling for a year—and delaying returns to shareholders—unless he expects prices to rise dramatically. He doesn’t.

“You have to be really bullish on prices to delay,” he said. “So we’ll take our best guess at the future, we’ll drill what looks economic and if there happens to be growth, there will be growth.”

Over the past year, shale producers have lowered their costs so much that the average break-even price for a barrel of U.S. crude is now in the upper $40s, down from $60, according to research from IHS Energy.

• Oil’s $4.4 Trillion Hole Deflation spreads through the global oil industry

(…) A year ago, futures indicated an average Brent crude-oil price in 2016 through 2018 of about $101 a barrel. Today, that is just under $60. Estimates of future demand have also been marked down slightly.

The implied hit to oil producers’ revenue is about $4.4 trillion spread across those three years.

It is also roughly three times the forecast capital expenditure of the global exploration and production sector, according to a recent survey of 474 oil companies by Cowen. (…)

Big state-backed producers in countries such as Saudi Arabia and Iran are price takersproducing oil for cash flow. Until U.S. onshore output is rationalized significantly—via retrenchment or mergers—the supply cuts necessary to rebalance the market and support prices will have to come from the bigger international projects traditionally operated by the majors.

But this would be a medium-term, rather than quick, process. BP Chief Executive Bob Dudleysaid in a recent interview on the company’s website that he expects the oil-price recovery to look like a “long U.” Indeed, offshore drillers, more exposed to the majors’ plans, have suffered the worst drop of any oil-field services subsector, down roughly a third this year. (…)

• Oil Heads for Sixth Weekly Decline as Goldman Sees Extended Glut

• ‘Frack now, pay later,’ top services companies say amid oil crash Business is so tough for oilfield giants Schlumberger NV and Halliburton Co that they have come up with a new sales pitch for crude producers halting work in the worst downturn in years. It amounts to this: “frack now and pay later.”

(…) At Halliburton, some of the capital to finance the sales will come from $500 million in backing from asset manager BlackRock, part of a wave of alternative finance pouring into the energy industry that one Houston lawyer said on Thursday allows companies to “keep the engine running.”

When its second-quarter net profit tumbled by more than half a billion dollars to just $54 million, Halliburton’s Chief Executive Dave Lesar told analysts the company needed to find new revenue. The BlackRock money, he said, would allow Halliburton to “look at additional ways of doing business with our customers, different business models, push beyond where we have been today.” (…)

Another variant, which Halliburton has considered and Schlumberger has pushed, is one in which the companies cover up-front costs for a producer and then get a piece of a well’s performance.

The services companies have made these special offers to producers in a bid to roll out the new business line of refracking, in which existing wells are worked over to lift output. (…)

EARNINGS WATCH

• 442 companies (90.5% of the S&P 500’s market cap) have reported. Earnings are beating by 5.3% while revenues have positively surprised by 0.4%.
• The beat rate is 71%. Ex-Financials: 74%
• Expectations are for revenue, earnings, and EPS of -3.4%, +0.6%, and +2.0%. EPS growth is on pace for 2.5%, assuming the current 5.3% beat rate for the remainder of the season. This would be 7.4% on a trend basis (ex-Energy and the big-5 banks).

Dollar Now Proves Costly to Revenues and Profits

A global glut of production capacity, a strong dollar, and industrial commodity price deflation weighed on Q2-2015’s sales and profits of US companies. The 87% of the S&P 500 companies that have released Q2-2015 results showed year-to-year setbacks of -4.9% for sales and -1.7% for operating profits. After excluding the energy sector’s deep year-to-year plunges of -33.0% for sales and -55.3% for operating income, the remaining members of the S&P 500 posted yearly increases of 1.0% for sales and 5.3% for profits.

Elsewhere, the annual decline by the sum of the sales of manufacturers, retailers, and wholesalers deepened from Q1-2015’s -1.2% to Q2-2015’s likely -2.0%. After excluding sales of identifiable energy products, the yearly growth of core business sales ebbed from Q1-2015’s 3.8% to Q2-2015’s 2.1%.

Unless sales accelerate convincingly, businesses are likely to spend more cautiously. Thus, second-half 2015’s average monthly increase by private-sector payrolls is likely to fall noticeably under first-half 2015’s 200,000 new jobs per month.

Faltering leadership

• Leading stocks continue to falter as the IBD 50 index of leading stocks did not rebound with the S&P and are now already back at their July lows ahead of the S&P
• The IBD 50 stock index is testing key support at US$24.20.
• Relative performance is negative increasing the probability of a breakdown.
• A further breakdown will see an extended trend of leadership stocks being hit. (NBF)

US equity markets are again stress testing important technical support ‘bands’ between the March/July lows (S&P ~2040) and 200- dma’s (2070) heading into this Friday’s ‘important’ NFP report and the seasonally weak time frame through the end of Q3. The market indexes continue to mask the wide range of chart price profiles from accelerating growth stocks, such as FB, to multi-quarter bear markets in most global cyclicals/resource stocks. (RBC Capital)

AMAZING AMAZON:

Amazon sales grew $5b in 2Q, accounting for 25% of overall retail sales growth, which was $20b. (ISI)